This week, the Islamic State announced that they will be minting coinage in gold, silver, and copper that will be "purely dedicated to Allah." Labeling modern currencies as a "tyrant's financial system," the move is designed to gain more control over the internal economy in the areas they control.

At the heart of their explanation is that all modern currencies are based in debt and part of a fractional reserve monetary system. Money enters the system through the central bank, then through the process of making loans the banking system creates more money -- debt drives the entire system. The Quran specifically forbids usury and some have interpreted all interest bearing debt as usury.

Historically, this is a colossal monetary policy mistake. No full reserve economy scheme has ever worked since the beginning of the Industrial Age, and such a move would guarantee economic isolation from the rest of the world.

But this is an issue of having more control over their economy. While dependent on foreign currency, it is very difficult for a government to consolidate power.

This is a very old topic of research; Adam Smith discusses it in the Wealth of Nations, published in 1776. In it, Smith notes that the government can control the value of currency due to the power they wield:

A prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money, even though the term of its final discharge and redemption should depend altogether upon the will of the prince.

Smith noted that the government's power of taxation can demand what form of payment the taxes are paid -- from British tally sticks to Babylonian clay pots, tax money has taken many different forms.

By creating a new currency, ISIS will employ far greater control over taxing its citizens. In short, the "golden rule" saying is wrong -- those who make the rules make the gold, instead of the other way around.

This move is not without its hypocrisy.

ISIS funds its operations through oil sales, ransoms, sales of stolen artifacts, and lastly taxes. While ISIS is imposing the new currency on their people, the other three "business activities" are still conducted within the "tyrant's financial system." Especially since all oil sales worldwide are denominated in U.S. dollars.

Historically, economies dependent on a foreign and a domestic currency do not function well. While some countries dabble in currency substitution by choice or expedience, dependency is usually a monetary nightmare. The reason is that once a government is dependent on a foreign currency, they lose a lot of their monetary policy ability.

For instance, if ISIS were to flood the market with coins to bolster the economy (even on a gold standard, the amount of gold in each coin is still worth less than the coin is valuated at -- allowing for at least some monetary policy), people's preference would turn to the U.S. dollar. This same phenomenon plagued the Confederacy during the Civil War, when U.S. currency was more highly regarded than the Confederate currency in the South.

All of this definitely indicates that this move has far more to do with consolidation of control and power in their own territories than establishing a real, legitimate monetary system. A legitimate monetary system assumes that ISIS is going to hold the territories it has taken over and form a lasting, stable government -- something very unlikely to happen. Other than becoming part of an obscure numismatic collection 100 years from now, this new currency will have little to no worldwide impact.

Photo Source: Reuters